Diversifying Macroeconomic Factors — For Better or for Worse
54 Pages Posted: 8 Jan 2021
Date Written: August 31, 2020
It is widely acknowledged that asset returns are driven by common sources of risk, especially in challenging times when the benefits from traditional portfolio diversification fail to realize. From a top-down perspective, investors are mostly concerned about shocks in growth or inflation that ultimately govern the pricing of broad asset classes. To this extent, we propose a natural asset allocation framework to achieve a diversified exposure to orthogonal macro risk factors and to harvest the associated long-term premia. We examine the role and usefulness of different types of macroeconomic variables, as systematic sources of risk or state variables that drive time variation in the asset returns, and compare their diversification potential across different states of the world.
Keywords: Macro Factors, Factor Investing, Diversification, Markov Switching
JEL Classification: C34, E44, G11, G12
Suggested Citation: Suggested Citation